Chapter2.

Basic Accounting Terms

1)Business
Transaction
 A business transaction is an economic activity of the business that changes its
financial position.
 Whenever any business transaction takes place, it results in a change in the values of
some of the assets, liabilities or capital.
The chief features of a transaction are:-
 It involves an economic activity. For example, when goods are purchased.
 Social activities are not considered as transactions. For example if X purchase a gift
for his friend, it will not be considered as a transaction.
 Transaction may be classified into two types- external and internal.
 External transactions are those which involve economic activities between
two independent business entities such as purchase or sale of goods.
 Internal transactions are those economic activities that take place entirely
within one business entity such as depreciation charged on fixed assets.
 It results in a change in the financial position of the firm – a change in the values of
some of the assets, liabilities or capital.
 The change must be capable of being expressed in terms of money.

2)Event:-
An event is the result of a transaction.

3) Account:-
 The individual transactions of similar nature are recorded, added and subtracted at
one place. Such place is known as an ‘Account’.
 In accounting, we keep a separate record of each individual, asset, liability, expenses
or income. The place where such a record is maintained is termed as an ‘Account’.
For example:-All transactions entered into with Ghanshyam will be recorded in the
Account of Ghanshyam.
 All accounts are divided into two sides. The left side of an account is called Debit side
and the right side of an account is called Credit side.
In the abbreviated form, Debit is written as Dr. and Credit is written as Cr. The account resembles English
capital letter ‘T’. As such, it is often called ‘T’ shape account. An account is abbreviated as A/c.

4) Capital:-
It refers to the amount invested by the proprietor [owner] in a business enterprise.
It is the amount with, the help of which goods and assts are purchased in the business.
Capital = Assets – Liabilities
Capital is also known as Owner’s Equity or Net Worth or Net Asset.

5) Drawing:-
Any cash or value of goods withdrawn by the owner for personal use or any private
payments made out of business funds are called drawings.
6) Liability:-
 It refers to the amount which the firm owes to outsiders (excepting the amount
owed to proprietors). This can be expressed as:-
Liabilities = Assets – Capitals
 The bills payable, creditors, unpaid wages are the examples of liability.
 Liability may be divided into two parts –
Internal liabilities
All amounts which a business entity has to pay to the proprietor or owners are internal
liabilities such as capital and accumulated profits.
External liabilities
All amounts which a business entity has to pay to the outsiders are known as external
liabilities such as creditors, bank overdraft, loans etc.

 Liabilities may be further classified into two parts as under:-

Non-current liabilities
These refer to those liabilities which fall due for payment in a relatively long period
(normally after more than one year). For example, long term loans and debentures etc.
Current liabilities
Current liabilities refer to those liabilities which are to be paid in near future (normally
within one year). For example, bank overdraft, bills payable, creditors, outstanding
expenses and short term loans etc.

7) Assets
 Anything which is in the possession or is the property of a business enterprise
including the amounts due to it from others, is called an asset.
 In other words, anything which will enable a business enterprise to get cash or a
benefit in future is an asset. This, cash and bank balances, stock, furniture,
machinery, land and building, bills receivable, money owning by debtors etc. are all
assets.
 Assets may be classified into the following categories –
A) Non-current asset
Non-current assets refer to those assets which are held for continued use in the business
for the purpose of producing goods or services and are not meant for sale.
Example for non-current assets are:- long term investments and fixed assets such as land
and building, plant and machinery, computer, motor vehicles, furniture etc.
Fixed assets are further classified into –
i) Tangible Assets:-
Tangible assets are those assets which can be seen and touched. In other words, which
have a physical existence such as land and building, plant and machinery, computer,
motor vehicle, furniture, stock, cash etc.
ii) Intangible Assets:-
Intangible assets are those assets which do not have a physical existence and this, cannot
be seen or felt. Examples of such assets are goodwill, patents, copyright, trade marks,
computer software and prepaid expenses.
 B) Current Assets
Current assets are those assets which are meant for sale or which the management would
want to convert into cash within one year. [Therefore, these assets are also termed as
‘short-lived or active assets’]

For example, debtors are expected to be converted in to cash within a reasonable short
period, stock is continuously sold and bills receivable are also converted into cash. current
assets are also known as floating assets or circulating assets

C) Fictitious or Nominal Assets

These are the assets which cannot be realized in cash or no further benefit can be derived
from these assets.
Such assets include Debit balance of P&L A/c and the expenditure not yet written off such
as Advertisement Expenses etc.
These assets are not really assets but are shown on the assets side only for the purpose of
transferring them to Profit & Loss Account gradually over a period of time.

8) Capital Receipts and Revenue Receipts

 The revenue receipts are shown on the credit side of Trading and Profit & Loss
Account
 Capital receipts are shown in the Balance Sheet either as increase in liabilities or as
reduction in the value of the assets.

Capital Receipts
Examples of capital receipts are
(i) Amount received from the sale of fixed assets or investments.
(ii) Capital contributed by proprietors, partners or money obtained from issue of shares
and debentures in case of company.
(iii) Amount received by way of loans.

Revenue Receipts
Money obtained from sale of goods.
Commission and fees received for services rendered.
Interest and dividend received on investment.
Expenditure
Any disbursement of cash or transfer of property or incurring a liability for the purpose of
acquiring assets, goods or services is called expenditure. It means that any type of
payment for the receipt of a benefit is termed as expenditure. Expenditure may be
classified into three categories (i) Capital expenditure, (ii) Revenue expenditure and (iii)
Deferred revenue expenditure.
Capital Expenditure
Any expenditure which is incurred in acquiring or increasing the value of a fixed asset is
termed as capital expenditure. As such, the amount spent on the purchase or erection of
Building, Plant, Furniture etc. is capital expenditure. Such expenditure yields benefit over a
long period and hence written in Assets.
Revenue Expenditure
Any expenditure, the full benefit of which is received during one accounting period is
termed as revenue expenditure. As such, all the revenue expenditure are debited to
Trading and Profit & Loss Account. Such only helps in maintaining the existing capacity.
 Distinction between Capital Expenditure and Revenue Expenditure
I. Capital expenditure is incurred for the acquisition or erection of a fixed asset,
whereas revenue expenditure is incurred for the day to day running of the
business.
II. Capital expenditure in incurred for the purpose of increasing the earning capacity
of the business, whereas revenue expenditure for maintenance of earning
capacity i.e., for keeping the assets in as efficient working order.
III. Capital expenditure yields benefit normally over a long period , whereas revenue
expenditure yields benefit for maximum period of one year.
IV. Capital expenditure is written in the balance sheet, whereas revenue expenditure
is written in Trading and Profit & Loss Account.

(i). Deferred Revenue Expenditure

There are certain expenditure which are revenue in nature but the
benefit of which is likely to be derived over a number of years. Such expenditure
are termed as ‘Deferred Revenue Expenditure’
The benefit of such an expenditure generally lasts between 3 to 7 years. As
such, the whole of such expenditure is not debited to the Profit and Loss Account
of the current year but spread over the years for which the benefit is likely to
last. Thus, only a part of such expenditure is taken to Profit & Loss Account every
year and the unwritten off portion is allowed to stand on the assets side of the
Balance Sheet. For example, a firm spent a huge amount of 2,00,000 on
advertising to introduce a new product in the market and it is estimated that its
benefit will last for 4 years. In this case, 50,000 will be charged to the P&L A/c of
each year for four consecutive years.
50,000 will be debited to P&L A/c of each year and the balance will be
treated as an assets and shown on the Assets side of the Balance Sheet.
1. Expenses
Expenses is the cost incurred in producing and selling the goods and services.
Following are included in the term Expenses
I. Cost of goods sold
II. Amount paid for Rent, Commission, Salary, Advertisement
etc.
III. Decline in the value of an assets caused by the use of such
asset for business purpose or depreciation is also an
expense.

2. Income
‘Income’ is different from ‘revenue’. Amount received from sale of goods is
called ‘Revenue’ and the cost of goods sold is called ‘Expense’. Surplus of revenue
over expenses is called ‘Income’. For example, the goods costing 4,00,000 are sold for
5,00,000. The sale amounting to 5,00,000 is the revenue, the cost amounting to
4,00,000 is expenses and the difference between the two i.e. 1,00,000 is the
income. It can thus, be expressed as
Income = Revenue – Expense
3. Profit
It is the excess of total revenues over total expenses of a business enterprise for
an accounting period.
Profit increases the investment of the owners.
4. Gain
It is a monetary benefit, profit or advantage resulting from events or
transactions which are incidental to business such as sale of fixed assets, winning a
court case or appreciation in the value of an asset. For example, if a building costing
10,00,000 is sold for 12,00,000; 2,00,000 will be the gain on sale of building.
13. Loss
The term conveys two different meanings. First, it conveys the result of the business
for a period when total expenses exceed the total revenues. For example, if revenues are
2,00,000 and expenses are 2,40,000, the loss will be 40,000. Second, activity against
which firm receives no benefit. For example, loss due to fire, theft, accident etc. It may be
noted that losses differ from expenses. Expenses are incurred to generate revenues
whereas losses do not. For example, the theft of an assets is a loss but its depreciation is an
expense.

15. Purchase
The term purchase is used only for the purchase of ‘Goods’ in which the business
deals. In case of a manufacturing concern ‘goods’ means acquiring of raw material for the
purpose of conversion into finished product and then sale. In case of trading concern
‘goods’ are those things which are purchased for resale. In both the cases the purpose is to
make a profit by its revenue. For example, if a cloth dealer purchases cloth for sale, the
cloth so purchased will be called ‘goods’. However, if the same cloth dealer purchases
furniture for seating the customers, such furniture will not be termed as goods, but it will
be an ‘Assets’ and a separate account named ‘Furniture Account’ will be opened for it.

Purchase Return :- When purchased goods are returned to the suppliers these are known
as purchase returns. Such returns are also termed as ‘returns outwards’.

16. Sales
Sales means transfer of ownership of goods or services to customer for a price. For
example, if Tarun sells a Computer to Varun, the ownership of computer will be transferred
form Tarun to Varun and Tarun is entitled to receive the agreed price of computer from
Varun. The term ‘sales’ is used only for the sales of those goods which are purchased for
resale purpose. It also includes revenues from services provided to customer. The term
‘sales’ is never used for the sale of assets. For example, if a cloth dealer sells cloth, it will be
termed as sales, but if the same cloth dealer sells old furniture or a typewriter, it will not be
termed as sales. The term sales includes both Cash and Credit sales.

Sales Return :- some customers might return the goods sold to them. Theses are termed as
sales returns or ‘returns inwards’.

17. Stock or Stock-in-trade

The term ‘stock’ includes the value of those goods which are purchased for reselling
and which are lying unsold at the end of accounting period. The sale may be two types.
(i) Opening Stock, (ii) Closing Stock.
 The term ‘Opening Stock’ means are the value of goods lying unsold at the beginning
of the accounting period whereas the term ‘Closing Stock’ means the value of goods lying
unsold at the end of the accounting period.

18. Inventory
In case of a manufacturer, there can be opening and closing inventory of four types.

(i). Inventory of Raw Material :- It includes inventory of raw material purchased for
using them in the products manufactured but still lying unused. For example, the
value of cotton in case of cloth mills is the inventory of raw material.
 (ii). Inventory of Work-in-progress :- It is also termed as inventory of partly finished
goods. It means goods in semi-finished form. Such goods need further processing for
converting into finished products. In case of cloth mills the value of threads and the
unfinished cloth will be the inventory of work in progress.
(iii). Inventory of Finished Goods :- It includes the inventory of those goods which have
been completely processed and are ready for sale but are lying unsold at the end of
the accounting period. In case of cloth miles the value of finished cloth will be the
value of finished goods.
(iv). Inventory of stock-in-trade :- In includes the value of those goods which are
purchased for reselling.

19. Trade Receivables

Trade receivables refer to the amount receivables on account of sale of goods or
services rendered by the company in the normal course of business.
Trade receivables include both Debtors and Bills Receivables.

Debtors :- The term ‘Debtors’ represents those persons of firms to whom goods
have been sold or services rendered on credit and payment has not been
received from them. They still owe some amount to the business. For example, if
goods worth 50,000 have been sold to Mohan on Credit, he will continue to
remain the debtor of the business so long as, he does not make the full payment.

Bill Receivables :- A bill of exchange becomes bill receivable for the person who
draws it (drawer) and gets it back, after its acceptance from the drawee. Thus bill
receivable is an accounting term for bills of exchange drawn on debtors or
received by way of endorsement from them. The amount specified in such a bill
is receivable at a future date.

20. Trade Payables

Trade payables is the amount payable on account of good purchased or services taken
in the natural course of business.
Trade payable include both ‘Sundry Creditors’ and ‘Bill Payables’.

Creditors :- The term ‘Creditors’ represents those persons or firms from whom
good have been purchased or services procured on credit and payment has not
been made to them. Some money is still owing to them. For example, if goods
worth 20,000 are purchased from Govind on Credit, he will continue to remain
the creditor of the firm so long as, the full payment is not made to him.
 Bill Payable :- A bill of exchange becomes bill payable for the person who accepts
it (drawee) and returns it to the drawer. Thus bill payable is an accounting term
for bills of exchange accepted in favour of creditors. The amount specified in such
a bill is payable at a future date.

21. Goods
Goods include all those things which are purchased for resale or which are used for
producing the finished products which are also meant to be sold. Thus, for a furniture
dealer purchase of chairs and tables is termed as goods, while for others it is future and is
termed as an asset. Similarly, for a stationary trader, stationary is goods, whereas for others
it is expense.
 22. Cost
Cost can be termed as the amount of resources given up in exchange for same goods
or services. The resources given up are money or money’s equivalent expressed in terms of
money. For example, cost of machinery will include purchase price, freight and installation
expenses etc. Further, the expenditure incurred may be actual or national. The amount
spent on the purchase of raw materials is the actual expenditure whereas national
expenditure is one which does not involve any cash outlay. National expenditure is
conceptual and deemed to have been incurred, e.g. rent of owned factory, interest on
owned capital etc.

23. Voucher
A voucher is a document which provides the authorization to pay and on the basis of
which the business transactions are, first of all, recorded in the books of accounts. A
separate voucher is prepared for each transaction and it specifies the accounts to be
debited or credited. The form of a voucher varies from firm to firm since vouchers are
printed separately by different firms I their own names. Vouchers are prepared by
accountant and each voucher is numbered and countersigned by an authorized person of
the firm.

24. Discount
It is a rebate or an allowance given by the seller to the buyer. It is of two types :
(i). Trade Discount :- When discount is allowed by a seller to its customers at a
fixed percentage on the list or catalogue price of the goods it is called trade
discount. It is not recorded in the books of accounts as it is deducted in the
invoice or cash memo itself from the gross value of goods.
(ii). Cash Discount :- When discount is allowed to the customers for making
prompt payment it is called cash discount. For example, if a seller allows 2%
discount for payment within a week it will be called cash discount. It is always
recorded in the books of accounts.

25. Entry
When a transaction or event is recorded in the books of accounts, it is called ‘Entry’

26. Bad Debts

It is the amount that has become irrecoverable from a debtor. It is a business loss
and is debited to Profit & Loss Account as an expenses.

27. Insolvent
A person or an enterprise which is not in a position to pay its debts in called insolvent.
28. Solvent
A person or an enterprise which is in a position to pay its debts in called solvent.

29. Stores
The term ‘stores’ is used to denote materials held by an enterprise for the purpose of
consumption in the business and not for resale. Examples are lubricants, spare parts of
machinery, packing materials etc.

30. Revenue
Revenue in accounting means the income of a recurring (regular) nature from any
source. It consists of the amount received from sale of goods and from service provided to
customers. Is also includes receipt
of rent, commission, dividend, interest etc. revenue is related with day-to-day affairs of the
business and should also be regular in nature.

31. Entity
An entity or business entity means an economic unit which is formed for earning
income by providing service or selling goods (for example L.G. Electronics, Wipro, Maruti
Suzuki etc.

32. Turnover
Turnover means total sales made in a particular period.

33. Livestock
Domestic animals, such as cattle or horses are known as livestock.

34. Investment
Investment refers to deployment of funds in the shares or debentures of companies
with the intention of earning a return.